Intel is the largest semiconductor producer in the world. It is largely known to consumers for producing the processors and chipsets in personal computers and notebooks, whether they be Windows-based or Apple. It holds about four fifths of the microprocessor market. The company also dominates in processors for servers, a sizable and growing segment of its overall business as the traditional PC market stagnates. Intel is now also trying to catch up in serving the smartphone and tablet industries, where it was late at producing energy efficient processors for those products. Intel also now has a software security service in its McAfee subsidiary, bought in 2010. It hopes to integrate more security features directly into its hardware.

I identified Intel for notching a score of 8 on Piotroski’s F-Score (I use the 10-point variant detailed in Tobias Carlisle and Wes Gray’s excellent book Quantitative Value, as well as on Wes Gray’s website Alpha Architect). It came up short only on the Current Ratio test and the Free Cash Flow on Assets test. More importantly, Intel is undervalued based on its ratio of Enterprise Value to Average (7 year) Book value, which is just under 3.0 times currently. While this superficially doesn’t seem particularly cheap, it is so in light of Intel generating strong average Returns on invested capital, well above its cost of capital. I estimate its Return on invested capital at 20% over the last 7 years, while I estimate its cost of capital to be 9%. These numbers should roughly indicative of Intel’s future capacity. The PC market, while contracting, is unlikely to completely die out, at least not too soon. Intel’s efforts in the mobile space appear to be starting to pay off and the server segment will continue to do well. Meanwhile, Intel’s financial position appears strong and it certainly has more resources than a lot of its competitors. Therefore I recommend it as a buy.

Laurentian Bank of Canada is a financial institution based in Montreal. The bank has four main business lines. Its Retail Services are offered through 156 branches in the province of Quebec (and 1 in Ottawa, Ontario), offering a wide line of personal banking services. The Commercial segment operates throughout the country, providing loans and other financing services to small and medium businesses. The bank claims to specialize especially in such niches as real estate developers, agriculture, health professionals and equipment financing. B2B Bank, the third main line, provides banking and investment solutions exclusively through independent financial advisors and non-bank financial institutions. This business in particular has grown significantly through recently acquiring other businesses such as AGF Trust and probably needs some time to adjust to its changes. The fourth segment, Laurentian Securities and Capital Markets, is focused mainly on investment banking and underwriting to small companies.

Laurentian Bank came up for meeting my modified Piotroski score for financial firms, obtaining a score of 5 out of 6. It’s only negative mark comes from issuing more shares compared to the previous year (a fairly recurring occurrence for the company in recent years). I also believe the company to be valued well below its intrinsic value, trading at about 1.07 times its average Book value. Also noteworthy, though it doesn’t factor in my calculations, Laurentian Bank pays a quarterly dividend of $0.56 a share, which translates to a hefty dividend yield of about 4%. The company reported quarterly earnings of $1.16 and $1.34 per share the last two quarters, so the dividend seems very sustainable and should be a reliable source of returns for the next few years.

Laurentian Bank has some acquisitions to digest from the last few years. But as it stands it trades at a substantial discount to its current value, at least compared to what other Canadian banks such as Canadian Western Bank trade at, with the further possibility of growth in its business across the country.

Sunday, August 16, 2015

I’ve thought for a long time about better ways to
select stocks in the financial sector. Many screens explicitly or indirectly
exclude financial stocks. It’s become a somewhat popular chorus in recent years
that financials are too risky or too opaque to invest in. However I do not take
this view, I’m of the opinion that no asset class or sector is inherently
unattractive. There is plenty of money to be made in analyzing financial stocks
judging by the portfolios of some of the more renown value funds such as
Arlington Value and Tweedy Browne.

I’ve settled for customizing Piotroski’s Fundamental F-Score
as a way of quickly and efficiently sorting promising financial companies from
the ugly ones. Recall that the original F-Score is a 9-point scoring system
used to screen promising stocks. For each of the 9 measurements that improved
over the last year, a company would score a 1; otherwise it would get 0. With
scores ranging from 0 to 9, companies with low scores were unattractive and
companies with higher scores were attractive. The F-Score alone was found to
produce good results historically. However, financial companies are explicitly
screened out. Indeed, a lot of the metrics would not apply to financial sector
stocks anyways. Therefore I removed from consideration the following tests that
I felt were irrelevant to the sector.

- Positive Free Cash Flow

- Current ratio improves over the previous year

- Gross margin improves over the previous year

- Total asset turnover improves over the previous year

I kept
the remaining 5 tests and added one more of my own to capture improvement in
overall leverage (from having thrown away the current ratio test), therefore
making it a 6-point scoring system, with the following tests:

Using Portfolio123’s screen building tool, I backtested
groupings of this modified Piotroski score against an equal-weighted portfolio of
all the Financial sector stocks in the total market S&P 1500 index.
Portfolios are formed every 4 weeks and held for 1 year from June 1999 to June
2015.

While the annually rebalanced portfolios of Financials
stocks averaged an annual return of 6.75%, portfolios of stocks with a modified
Piotroski score of 5 or 6 (out of 6) returned an average of 8.64%, portfolios
of stocks with scores of 3 or 4 averaged 6.54%, while portfolios of stocks that
scored 2 or less only returned 4.20%. This suggests that there is a good way of
systematically choosing stocks in the financial sector. There might be other
systematic methods, and some other criteria should likely be applied, namely the
nature of the business, low valuation in relation to earnings or book value, etc.
But this is a good, simple starting point for researching financial stocks and
is the first criteria I use for selecting and recommending companies in that
sector.